37668 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations

1 17 CFR 240.17a–5. Rule 17a–5 was adopted by

the Commission pursuant to authority under

Section 17 of the Exchange Act [15 U.S.C. 78q], and

particularly Section 17(e) [15 U.S.C. 78q(e)], which

requires every broker- dealer to file annually with

the Commission a certified balance sheet and

income statement, and such officer information

concerning its financial condition as the

Commission may prescribe.

2Release Nos. 34–39724; IC–23059; IA–1704,

(March 5, 1998), 63 FR 12056 (March 12, 1998)

(’’Proposing Release’’).

3The Proposing Release defined the term ‘‘Year

2000 Problem’’ to include any erroneous result

caused by any computer software (i) incorrectly

reading the date ‘‘01/01/00’’ or any year thereafter;

(ii) incorrectly identifying a date in the year 1999

or any year thereafter; (iii) failing to detect that the

Year 2000 is a leap year, and (iv) any other

computer error that is directly or indirectly related

to (i), (ii), or (iii) above.

4All comment letters are available in File No. S7–

7–98 at the Commission’s Public Reference Room,

450 Fifth Street, NW, Washington, DC 20549. The

comment period closed on April 27, 1998. See also

Release Nos. 34-39858; IC–23112; IA–1716

(extending the comment period from April 13, 1998

to April 27, 1998).

5Of the 35 comment letters received, five were

opposed to any additional regulatory requirements.

6The broker-dealer’s assertions and the related

accountant’s attestation report would have been

required to be filed only with the second report.

7 17 CFR 240.17a–3.

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 240

[Release No. 34–40162; File No. S7–7–98]

RIN 3235–AH36

Reports to be Made by Certain Brokers

and Dealers

AGENCY:Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange

Commission (‘‘Commission’’) is

amending Rule 17a–5 under the

Securities Exchange Act of 1934

(‘‘Exchange Act’’) to require brokerdealers to file with the Commission and

their designated examining authority

(‘‘DEA’’) at designated times two

separate reports regarding their Year

2000 compliance. The reports will

increase broker-dealer awareness that

they should be taking specific steps now

to prepare for the Year 2000; facilitate

coordination with self regulatory

organizations of industry-wide testing,

implementation, and contingency

planning; supplement the Commission’s

examination module for Year 2000

issues and identify potential Year 2000

problems; and provide information

regarding the securities industry’s

preparedness for the Year 2000. The

reports are designed to be available to

the public which will enable brokerdealer counterparties and others to

assess the risks of doing business with

a broker-dealer that may not be Year

2000 compliant.

EFFECTIVE DATE: August 12, 1998.

FOR FURTHER INFORMATION CONTACT:

Michael A. Macchiaroli, Associate

Director, 202/942–0131; Thomas K.

McGowan, Assistant Director, 202/942–

4886; Lester Shapiro, Senior

Accountant, 202/942–0757; or

Christopher M. Salter, Staff Attorney,

202/942–0148, Division of Market

Regulation, Securities and Exchange

Commission, 450 Fifth Street, NW, Mail

Stop 10–1, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

At midnight on December 31, 1999,

unless the proper modifications have

been made, the program logic in many

of the world’s computer systems will

start to produce erroneous results

because, among other things, the

systems will incorrectly read the date

‘‘01/01/00’’ as being the year 1900 or

another incorrect date. In addition,

systems may fail to detect that the Year

2000 is a leap year. Problems can also

arise earlier than January 1, 2000, as

dates in the next millennium are

entered into non-Year 2000 compliant

programs.

The Commission views the Year 2000

problem as an extremely serious issue.

A failure to assess properly the extent of

the problem, remediate systems that are

not Year 2000 compliant, and then test

those systems could endanger the

nation’s capital markets and place at

risk the assets of millions of investors.

In light of this, both the broker-dealer

industry and the Commission are

working hard to address the industry’s

Year 2000 problems.

As part of its ongoing efforts relating

to the Year 2000, on March 5, 1998, the

Commission requested comment on

proposed amendments to Rule 17a–5 1

that would require certain brokerdealers to file reports with the

Commission and their DEA regarding

Year 2000 compliance.2 In particular,

the Commission sought comment on: (i)

the definition of the term ‘‘Year 2000

Problem;’’ 3 (ii) the minimum net capital

reporting threshold; (iii) the proposed

reporting content; (iv) the requirement

that portions of the report be attested to

by independent public accountants; and

(v) the public availability of the

information to be reported.

The Commission received 35

comment letters in response to the

Proposing Release.4 The majority of the

commenters generally supported the

Commission’s proposals and made

suggestions for improving one or more

aspects of the proposed amendments.5

However, the majority of the

commenters objected to the attestation

requirement and the $100,000 minimum

net capital threshold for determining

which broker-dealers would be required

to file Year 2000 reports under the

proposed amendments. The majority of

the commenters that addressed the issue

of whether the information reported

should be publicly available, objected to

the Year 2000 reports and related

accountant’s attestation report being

made public. Based on the comments

received, the Commission is adopting

the proposed amendments with the

changes discussed below.

II. Description of the Proposed Rule

Amendments

Under the proposed amendments, a

broker-dealer that is required to

maintain minimum net capital of

$100,000 or greater as of either

December 31, 1997, or December 31,

1998, would have been required to file

two reports at specified times with the

Commission and its DEA regarding its

efforts to address Year 2000 Problems.

The first of these reports would have

evaluated the efforts of the broker-dealer

as of December 31, 1997, and would

have been required to be filed no later

than 45 days after the Commission

adopted the proposed rule amendments.

The second report would have

evaluated the broker-dealer’s efforts as

of the date of its financial statements for

fiscal year-end 1998. This report would

have been required to be filed within 90

days after the date of its fiscal year-end

financial statements.

As part of the second report, each

reporting broker-dealer would have

been required to make assertions about

its efforts to prepare for the Year 2000.

For example, a broker-dealer would

have been required to assert whether or

not it has a plan to address Year 2000

Problems. In addition to making the

assertions, each reporting broker-dealer

would have been required to engage an

independent public accountant to attest

to whether there was a reasonable basis

for the broker-dealer’s assertions.6

As noted in the Proposing Release, the

Commission has advised broker-dealers

that if a broker-dealer’s computer

systems have Year 2000 Problems, the

broker-dealer may be deemed not to

have accurate and current records and

be in violation of Rule 17a–3 under the

Exchange Act.7 The Commission also

reminded broker-dealers that Rule 17a–

11 under the Exchange Act requires

every broker-dealer to promptly notify
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37669

8 17 CFR 240.17a–11(d).

9As explained in the Proposing Release, under

the proposed $100,000 net capital threshold,

approximately 5,600 out of 7,800 registered brokerdealers would be exempt from the Year 2000

reporting requirements.

10 In light of the AICPA’s comment letter and

ongoing efforts, in a companion release also issued

today the Commission is re-opening the comment

period with respect to the proposal to have an

independent public accountant review a brokerdealer’s second Year 2000 report. The public file

(No. S7–7–98) will include both the AICPA’s

original comment letter and any follow-up letter

submitted by the AICPA for the Commission’s

consideration.

the Commission of its failure to make

and keep current books and records.8

III. Discussion of Final Rule

Amendments

A. Reporting Threshold

In the Proposing Release, the

Commission proposed the $100,000

minimum net capital reporting

threshold because broker-dealers subject

to this minimum net capital level are

likely to have substantial financial

exposure to the market and to

customers. This threshold would have

required all dealers, market makers, and

clearing firms to file the Year 2000

reports.

Several commenters, including the

National Association of Securities

Dealers (‘‘NASD’’), expressed concern

about the proposed net capital threshold

because that threshold excludes nearly

72% of all registered broker-dealers

from reporting on their efforts to address

Year 2000 Problems.9 These

commenters stated that the

Commission’s proposal does not gather

adequate information regarding the risks

posed by the Year 2000 because the

proposed threshold would exclude

many firms that execute thousands of

transactions each trading day effecting

thousands of customers, market makers,

and dealers. These commenters argued

that the failure on the part of a large

number of excluded broker-dealers to

adequately prepare for the Year 2000

could have negative systemic effects on

the world’s financial markets.

While mindful of the burden on small

broker-dealers, the Commission is

addressing this comment by requiring

each broker-dealer with a minimum net

capital requirement of $5,000 or greater

to file reports with the Commission and

with its DEA that discuss its efforts to

address Year 2000 Problems. Brokerdealers that have a minimum net capital

requirement of less than $100,000 will

only be required to file a less

burdensome check-the-box style Year

2000 report. Broker-dealers that meet a

$100,000 minimum net capital reporting

threshold will be required to file, in

addition to the check-the-box report, a

more detailed narrative discussion of

their Year 2000 efforts. The format for

broker-dealers to report on their efforts

to address Year 2000 Problems is

discussed in more detail in paragraph

III.F. below.

B. Attestation Requirement

The Proposing Release would have

required each broker-dealer to have an

independent public accountant attest to

several specific assertions included in

the second Year 2000 report. The

Commission believed it was important

to have an independent third party

affirm that there was a reasonable basis

supporting the broker-dealer’s

assertions.

As proposed, each broker-dealer

would have been required to assert:

(1) whether it has developed written

plans for preparing and testing its

computer systems for potential Year

2000 Problems;

(2) whether the board of directors, or

similar body, has approved these plans,

and whether a member of the brokerdealer’s board of directors, or similar

body, is responsible for executing the

plans;

(3) whether its Year 2000 remediation

plans address all domestic and

international operations, including the

activities of its subsidiaries, affiliates,

and divisions;

(4) whether it has assigned existing

employees, hired new employees, or

engaged third parties to execute its Year

2000 remediation plans; and

(5) whether it has conducted internal

and external testing of its Year 2000

solutions and whether the results of

those tests indicate that the brokerdealer has modified its software to

correct Year 2000 problems.

The American Institute of Certified

Public Accountants (‘‘AICPA’’)

commented that the required attestation

report would be difficult for

independent public accountants to

provide. The AICPA said that some of

the required broker-dealer assertions are

not appropriate for accountant

attestation because the assertions are not

capable of reasonably consistent

measurement against reasonable criteria.

Currently, there are no established

criteria related to Year 2000 remediation

efforts. The lack of established criteria

would likely result in significant

variation in the examination procedures

performed by independent public

accountants and thus reduce the

usefulness of the attestation reports. In

addition, the AICPA expressed concern

that the purpose and conclusions of the

attestation report could be

misunderstood. The AICPA was

primarily concerned that uninformed

users of the attestation reports would

place undue reliance on them.

The AICPA suggested that an ‘‘agreedupon procedures’’ engagement, instead

of an attestation engagement, would

more effectively meet the Commission’s

goals. Pursuant to such an engagement,

a broker-dealer would engage an

independent public accountant to

perform and report on specific

procedures designed to meet the

Commission’s objectives. This would

eliminate the variability of examination

procedures performed by independent

public accountants and thus increase

the consistency of the reports received

by the Commission. The AICPA’s letter

outlined elements of an agreed-upon

procedures report and offered to followup with the Commission staff regarding

the development of specific procedures

for a Year 2000 engagement.

The Commission is deferring

consideration of whether to adopt a

requirement that the second report be

evaluated by an independent public

accountant. The Commission, however,

will consider such a requirement if the

accounting industry recommends a

standard which can be used by public

accountants in connection with the

second report.10

C. Public Availability

The proposed rules would have made

a broker-dealer’s Year 2000 reports,

including the attestation by the

independent public accountant,

available to the public. The Commission

recognizes commenters’ concerns that

some users of these reports could place

undue reliance on the reports, the

technical nature of the reports could

confuse investors, detailed testing

reports could be misleading and

unnecessarily alarming, and the reports

could contain confidential proprietary

information.

However, the Commission believes

that the public’s interest is best served

by requiring full and open disclosure.

Allowing the public, particularly other

broker-dealers and counterparties, to

have access to the information reported

by broker-dealers will enable interested

persons to assess the Year 2000

readiness of a broker-dealer with which

they are doing business. For example,

after receiving a counterparty’s report,

another broker-dealer might request

additional information or assurances if

the counterparty does not appear to be

taking the steps necessary to be Year

2000 compliant. In the absence of such

assurances, the other broker-dealer

could determine whether it wishes to
37670 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations

11The first of these reports would have evaluated

the efforts of broker-dealers as of December 31,

1997, and would have been required to be filed no

later than 45 days after the Commission adopted the

proposed rule amendments. The second report

would have evaluated broker-dealer efforts as of the

date of their financial statements for fiscal year-end

1998. This report would have been required to be

filed within 90 days after the date of their financial

statements.

12New broker-dealers who register between

January 1, 1999 and March 15, 1999, are required

to file a report on their Year 2000 efforts no later

than April 30, 1999. This report should reflect their

Year 2000 efforts as of March 15, 1999.

13This includes whether the broker-dealer has

assigned existing employees, hired new employees,

or engaged third parties to provide assistance in

avoiding Year 2000 Problems.

14These stages are: (i) awareness of potential Year

2000 Problems; (ii) assessment of what steps must

be taken to avoid Year 2000 Problems; (iii)

implementation of the steps needed to avoid Year

2000 Problems; (iv) internal testing of software

designed to avoid Year 2000 Problems; (v)

integrated or industry-wide testing of software

designed to avoid Year 2000 Problems (including

testing with other broker-dealers, other financial

institutions, customers, and vendors); and (vi)

implementation of tested software that will avoid

Year 2000 Problems.

15Contingency planning should provide for

adequate protections to ensure the success of

critical systems if interfaces fail or unexpected

problems are experienced with operating systems

and infrastructure software. In addition,

contingency plans should provide for the failure of

external systems that interact with the brokerdealer’s computer system. For example,

contingency plans should anticipate the failure of

a vendor that services mission critical applications

and should provide for the potential that a

significant customer experiences difficulty due to

Year 2000 problems.

continue its dealings with that brokerdealer.

Accordingly, the final rule provides

that these reports will be available to the

public.

D. Timing

The Proposing Release established asof dates and due dates for the reports

broker-dealers were required to file.11

Some commenters explained that, in the

absence of an existing requirement to

make and retain records detailing Year

2000 remediation efforts as of December

31, 1997, the information to prepare the

reports may not be available. In

addition, several commenters stated that

reporting Year 2000 status as of

December 31, 1997 would provide data

that is outdated and misleading. Finally,

some broker-dealers commented that

they have fiscal years that end in mid

to late 1998, and that the proposed due

dates and as-of-dates for the first and

second reports would have required

some broker-dealers to file their reports

virtually back-to-back.

The rule adopted by the Commission

today requires a broker-dealer to file its

first report with the Commission and its

DEA by August 31, 1998. This report

should reflect the status of the brokerdealer’s Year 2000 efforts as of July 15,

1998. The second report must be filed

with the Commission and the brokerdealer’s DEA by April 30, 1999, and

should reflect the status of the brokerdealer’s Year 2000 efforts as of March

15, 1999.

The rule adopted today also requires

new broker-dealers who register as a

broker-dealer between July 16, 1998 and

December 31, 1998, to file with the

Commission and its DEA no later than

30 days after its registration becomes

effective the first report on its Year 2000

compliance as of the date of its

registration. In addition, the rule also

requires new broker-dealers who

register as a broker-dealer between

March 16, 1999 and October 1, 1999, to

file with the Commission and its DEA

no later than 30 days after its

registration becomes effective a report

on its Year 2000 compliance as of the

date of its registration.12

E. Reporting Requirements

As previously discussed, the

Proposing Release would have required

each reporting broker-dealer to discuss

the steps it has taken to address Year

2000 Problems. More specifically, each

broker-dealer would have been required

to (i) indicate whether its board of

directors, or similar body, has approved

and funded written Year 2000

remediation plans that address all major

computer systems; (ii) describe its Year

2000 staffing efforts, and the work

performed by Year 2000 dedicated

staff; 13 (iii) discuss its progress on each

stage of preparation for the Year 2000; 14

(iv) indicate if it has written

contingency plans to deal with Year

2000 problems that may occur; 15 and (v)

identify what levels of management are

responsible for Year 2000 remediation

efforts.

The Securities Industry Association

(‘‘SIA’’) suggested some changes to the

specific reporting requirements to better

clarify the information sought by the

Commission. For example, the

Proposing Release would have required

broker-dealers to discuss the work

performed by Year 2000 dedicated staff

on an individual basis. In addition,

broker-dealers would have been

required to identify the levels of

management involved in the Year 2000

efforts, discuss the specific

responsibilities of these managers, and

provide an estimate of the time they

have spent on Year 2000 efforts. The

SIA explained that these proposed

requirements may be very burdensome.

Fixing Year 2000 problems may require

the dedicated efforts of a significant

number of employees and consultants.

In addition, the tasks and

responsibilities involved may be

detailed, extensive, and constantly

changing.

The proposed rule also would have

required broker-dealers to report the

number and nature of the exceptions

resulting from both internal and

integrated testing of software designed

to avoid Year 2000 Problems. The SIA

commented that this requirement would

likely provide meaningless information.

The SIA explained that testing software

is a dynamic process that in many

instances requires exceptions to be

identified hourly, daily, and weekly. In

addition, identified exceptions may be

immediately addressed, causing new

exceptions to emerge. This process may

repeat itself many times before testing is

finished. Consequently, by the time the

Commission received the Year 2000

reports, the exceptions discussed in

them may have been addressed and new

exceptions identified.

The Commission agrees that some

modification of the reporting

requirements is warranted. The rule

adopted today requires each brokerdealer completing the narrative portion

of Form BD–Y2K to provide a summary

of the efforts of Year 2000 dedicated

individuals or groups of individuals.

The broker-dealer will not have to

provide an estimate of the time that its

management has spent on Year 2000

efforts. Finally, the broker-dealer must

report the number and description of

material exceptions identified during

the internal and external testing of its

software that are unresolved as of the

report date. The Commission is leaving

the determination of what constitutes a

material exception to the broker-dealer’s

judgment.

F. Report Format

The Proposing Release would have

required each broker-dealer meeting the

$100,000 minimum net capital

threshold to discuss, in narrative format,

its efforts to address Year 2000

Problems. The National Association of

Securities Dealers Regulation, Inc.

(‘‘NASDR’’) commented that the

Commission should prescribe a format

for a broker-dealer to use when

reporting on its Year 2000 efforts. More

specifically, the NASDR suggested that

the Commission prescribe an objective

reporting format, such as a check-thebox questionnaire. The NASDR

explained that an open narrative format

may lead to great disparity in the nature

and detail of the reports that brokerdealers would submit. Providing a

reporting format would produce

consistent results, improve the accuracy

and comparability of reports received,

and reduce the time required to
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37671

16For a copy of Form BD–Y2K see Attachment A.

17 15 U.S.C. 78w (a)(2).

18 15 U.S.C. 78c.

19Field tests of Part I of Form BD–Y2K indicated

that it could be completed in as little as 30 minutes.

However, the Commission believes that it may take

longer for some broker-dealers to complete Part I of

Form BD–Y2K.

summarize, track, analyze, and report

the information received.

The Commission recognizes the value

of receiving the requested information

in an objective format and that

prescribing such a format would

decrease the burden that the Year 2000

reporting requirements impose on

broker-dealers. However, the

Commission also is concerned that

limiting the reporting requirements to a

check-the-box format for broker-dealers

that pose the greatest risk to customers

and the market will not provide the

Commission or the DEAs sufficient

information to effectively review for

Year 2000 compliance.

The rule the Commission adopts

today requires each broker-dealer with a

minimum net capital requirement of

$5,000 or greater to file with the

Commission and its DEA Part I of a new

Form BD–Y2K.16 Part I of Form BD–Y2K

is a check-the-box Year 2000 report that

generally addresses the same issues the

proposed narrative discussion

addresses. Each broker-dealer that is

required to maintain net capital of

$100,000 or greater will be required to

file Part II of Form BD–Y2K, which

requires a narrative discussion of its

efforts to address Year 2000 Problems.

The narrative discussion is designed to

provide the Commission and the DEA’s

with additional information on the Year

2000 efforts of those broker-dealers who

pose the greatest risk to customers and

the market if they are not Year 2000

compliant.

Copies of Form BD–Y2K are available

in Commission’s Public Reference Room

located at 450 Fifth Street, NW,

Washington, DC 20549 or copies can be

obtained from the Commission’s

internet web site at the following

address: www.sec.gov.

IV. Costs and Benefits of the Rules and

Their Effects on Competition,

Efficiency, and Capital Formation

Section 23(a) of the Exchange Act 17

requires the Commission, in adopting

rules under the Exchange Act, to

consider the competitive effects of such

rules and to not adopt a rule that would

impose a burden on competition not

necessary or appropriate in furthering

the purposes of the Exchange Act.

Furthermore, Section 3(f) of the

Exchange Act 18 provides that whenever

the Commission is engaged in

rulemaking and is required to consider

or determine whether an action is

necessary or appropriate in the public

interest, the Commission also shall

consider, in addition to the protection of

investors, whether the action will

promote efficiency, competition, and

capital formation.

The Commission has considered the

amendments to Rule 17a–5 in light of

the standards cited in Sections 3 and 23

(a)(2) of the Exchange Act. In the

Proposing Release, the Commission

requested that commenters provide

analysis and data supporting the costs

and benefits of the proposed

amendments. In addition, the

Commission sought comments on the

proposed amendments’ effect on

competition, efficiency, and capital

formation.

Several commenters indicated that the

Commission’s cost estimates were too

low. However, no commenters provided

detailed information or data as to the

costs of the proposed amendments. One

commenter addressed the issue of

whether the proposed amendments

would affect competition. Finally, no

comments were received regarding the

proposed amendments effect on

efficiency and capital formation.

A. Cost Benefit Analysis

Based on comments received, the

Commission has revised the proposed

amendments the result of which is to

lower the aggregate cost of compliance

with the rule. As discussed above, the

Commission is adopting new Form BD–

Y2K and is expanding the requirement

that a broker-dealer report on its Year

2000 efforts to each broker-dealer with

a minimum net capital requirement of

$5,000 or greater. Each of these brokerdealers is required to file Part I of Form

BD–Y2K, a check-the-box Year 2000

report. Each broker-dealer that meets the

$100,000 minimum net capital reporting

threshold is required to also complete

Part II of Form BD–Y2K.

The Commission is also deferring

consideration of whether to require

broker-dealers to engage independent

public accountants to examine their

efforts to address Year 2000 Problems.

The Commission is allowing brokerdealers to summarize by group the

efforts of Year 2000 dedicated

individuals as opposed to requiring

individual descriptions of these

people’s efforts. Broker-dealers will not

have to provide an estimate of the time

management has spent on Year 2000

efforts. Finally, broker-dealers are only

required to report the number and

description of unresolved material

exceptions identified during the internal

and external testing of their software.

Based on field testing of Part I of Form

BD–Y2K conducted by the Office of

Compliance Inspections and

Examinations, the Commission

estimates that on average a broker-dealer

will spend approximately two hours

completing Part I of Form BD–Y2K

resulting in a total cost to the industry

of $2,400,000.19 This is based on 6,000

respondents spending four hours at

$100 per hour preparing two reports

consisting of Part I of Form BD–Y2K.

The Commission estimates that on

average a broker-dealer will spend 35

hours completing Part II of Form BD–

Y2K resulting in a total cost to the

industry of $15,400,000. This is based

on 2,200 broker-dealers spending 70

hours at $100 per hour preparing two

reports consisting of Part II of Form BD–

Y2K. Therefore, based upon the

adjustments to the proposed rule, the

Commission has revised its cost to the

industry to a total of $17,800,000

($2,400,000 + $15,400,000). It is

important to note that this is a total cost

estimate and not an annual cost. Brokerdealers will only be required to prepare

and file two Form BD–Y2Ks.

No commenters addressed the

potential benefits of the amendments,

and the Commission has not been able

to quantify those benefits. However, the

Commission believes that the benefits

will outweigh the costs. The

Commission is aware of the significant

effort the securities industry has put

forth and the progress it has made but

believes that significant progress still

needs to be made by the securities

industry to be ready for the Year 2000.

The Commission does not yet have

comprehensive information regarding

the readiness of the broker-dealer

industry for the Year 2000. Although the

NASD and the NYSE have conducted

surveys of their members, not all

members responded to the survey and

some of those who did submitted

incomplete responses. It is important for

the Commission to obtain complete

information from individual brokerdealers to permit the Commission and

Self Regulatory Organizations (‘‘SROs’’)

to assess the risks associated with firms

that fail to show adequate Year 2000

progress. Moreover, the Commission

believes that a regulatory requirement to

file Year 2000 reports should encourage

broker-dealers to proceed expeditiously

with their efforts to prepare for the Year

2000. The Commission will use the

reported information to obtain a more

complete understanding of the

industry’s overall Year 2000

preparations and to identify firmspecific and industry-wide problems.

Information in the reports will help the
37672 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations

20 17 CFR 240.0–10(c).

21The proposed rule amendments would have

affected approximately 600 small broker-dealers.

The reasons for expanding the Year 2000 reporting

requirements are discussed in paragraph III.A.

above.

Commission focus its Year 2000-related

efforts for the rest of 1998 and 1999 on

particular industry segments or firms

that appear to pose the greatest risk of

non-compliance.

In sum, the rule amendments will

enable the Commission to take a more

active role in reducing the Year 2000

risk to the securities industry. The

reports broker-dealers will be required

to file will enable the Commission and

the SROs to (i) better monitor the

industry’s Year 2000 readiness; (ii)

increase broker-dealer awareness that

they should be aggressively preparing

for the Year 2000; (iii) coordinate

industry-wide testing, implementation,

and contingency planning; and (iv)

enable the Commission to identify

potential compliance problems.

B. Efficiency, Competition, and Capital

Formation

In the Proposing Release, the

Commission stated that the proposed

amendments should not unduly burden

competition. One commenter addressed

the proposed amendment’s effect on

competition. This commenter stated that

the proposed amendments could have

an anticompetitive effect because the

amendments exclude nearly 72% of

registered broker-dealers from having to

report on their efforts to address Year

2000 Problems.

The Commission has drafted the rule

amendments so as to minimize their

impact on competition. As discussed

above, the Commission adjusted the

proposed amendments to require each

broker-dealer with a minimum net

capital requirement of $5,000 or greater

to report on its Year 2000 efforts in

order to gather adequate information

regarding the industry-wide risks posed

by the Year 2000 Problem. However, the

Commission has structured the form of

the report to differentiate between

broker-dealers based upon their size,

type of business, and relative risk they

pose to customers and the market if they

are not Year 2000 compliant. Brokerdealers that do not meet the $100,000

minimum net capital reporting

threshold are only required to file the

Year 2000 report. Broker-dealers that

meet the $100,000 minimum net capital

reporting threshold are required to

provide additional information. The

Commission believes that the proposed

amendments do not impose any burden

on competition not necessary or

appropriate in furtherance of the

Exchange Act.

The Commission believes that the

amendments should increase the

efficiency and effectiveness of the

industry’s efforts to prepare for the Year

2000 by increasing awareness, focusing

industry efforts, and providing critical

information for identifying and

remedying problems. In addition, the

Commission believes that the

amendments do not adversely affect

capital formation. However, failure on

the part of the securities industry to

adequately prepare for the Year 2000

could adversely affect capital formation

at the beginning of the next millennium.

V. Summary of Final Regulatory

Flexibility Analysis

A final Regulatory Flexibility

Analysis (‘‘FRFA’’) concerning the

amendments to Rule 17a–5 has been

prepared in accordance with the

provisions of the Regulatory Flexibility

Act (‘‘RFA’’), as amended by Pub. L.

104–121, 110 Stat. 847, 864 (1996), 5

U.S.C. 604. The FRFA notes that the

amendments to Rule 17a–5 will enable

the Commission to (i) monitor the steps

broker-dealers are taking to address Year

2000 Problems; (ii) increase brokerdealer awareness that they should be

taking specific steps now to prepare for

the Year 2000; (iii) facilitate

coordination with SROs on industrywide testing, implementation, and

contingency planning; and (iv)

supplement the Commission’s

examination module for Year 2000

issues.

The Commission received no

comments on the Initial Regulatory

Flexibility Analysis (‘‘IRFA’’) prepared

in connection with the proposing

release, and no comment letters

specifically addressed the IRFA.

However, as discussed in paragraphs

III.A and IV.A above, certain

commenters expressed concern about

the threshold for determining which

broker-dealers are required to report on

their efforts to prepare for the Year

2000, and the estimated costs associated

with obtaining the independent public

accountant’s attestation.

As discussed more fully in the FRFA,

the rule will affect small entities. When

used with reference to a broker or

dealer, the Commission has defined the

term ‘‘small entity’’ to mean a broker or

dealer (‘‘small broker-dealer’’) that: (1)

had total capital (net worth plus

subordinated liabilities) of less than

$500,000 on the date in the prior fiscal

year as of which its audited financial

statements were prepared pursuant to

section 240.17a–5(d) or, if not required

to file such statements, a broker or

dealer that had total capital (net worth

plus subordinated liabilities) of less

than $500,000 on the last business day

of the preceding fiscal year (or in the

time that it has been in business, if

shorter); and (2) is not affiliated with

any person (other than a natural person)

that is not a small business or small

organization as defined in this release.20

Based on FOCUS data for the fourth

quarter of 1996, the latest information

available, the Commission estimates

that there are approximately 5,300 small

broker-dealers. Of these 5,300 small

broker-dealers, approximately 3,800 are

affected by the amendments to Rule

17a–5.21

The Commission has drafted the rule

amendments so as to minimize their

impact on small broker-dealers while

enhancing investor protection and

minimizing any impact on competition,

in part, by adopting different reporting

requirements to take into account the

resources available to small brokerdealers. The rule amendments require

broker-dealers with a minimum net

capital requirement of $5,000 or greater

to report on their efforts to address Year

2000 problems. However, approximately

1,500 small broker-dealers who do not

have a minimum net capital

requirement are exempt from reporting

on their Year 2000 efforts. In addition,

the Commission has adopted two

reporting formats for broker-dealers to

use when reporting on their efforts to

prepare for the Year 2000.

Of the 3,800 small broker-dealers

required to report on their Year 2000

efforts, approximately 3,200 (84%) are

only required to file a check-the-box

style Year 2000 report. As noted in the

cost-benefit section above, the

Commission estimates that it would take

each of these broker-dealers

approximately 2 hours to complete the

check-the-box Year 2000 report. The

remaining 600 (16%) small brokerdealers are required to provide, in

addition to the check-the-box style

report, a more extensive narrative

discussion of their Year 2000 efforts

because the type of business that these

broker-dealers conduct poses a greater

risk to customers and the market if they

are not Year 2000 compliant. Thus, by

adopting different reporting

requirements and by exempting those

broker-dealers who do not have a

minimum net capital requirement, the

Commission has imposed no burden, or

only a very limited burden, on

approximately 4,700 (89%) small

broker-dealers.

The FRFA notes that it would be

difficult to further simplify, consolidate,

or adjust compliance standards for small

broker-dealers and be able to effectively

monitor the securities industry’s efforts
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37673

22 44 U.S.C. 3501 et seq.

23 44 U.S.C. 3507.

to prepare for the Year 2000. The

Commission believes that the alternative

reporting requirement adopted for small

broker-dealers strikes the appropriate

balance between the need to protect

investors and the need to minimize the

impact on small broker-dealers. The

Commission also considered the use of

performance rather than design

standards. However, the Commission

concluded that it would be inconsistent

with the purpose of the rule to use

performance standards to specify

different requirements for small entities.

A copy of the FRFA may be obtained

by contacting Christopher M. Salter,

Staff Attorney, U.S. Securities and

Exchange Commission, Mail stop 10–1,

450 Fifth Street, NW., Washington, DC

20549.

VI. Paperwork Reduction Act

As set forth in the Proposing Release,

the amendments to Rule 17a–5 contain

collections of information within the

meaning of the Paperwork Reduction

Act of 1995 (‘‘PRA’’).22 Accordingly, the

collection of information requirements

were submitted to the Office of

Management and Budget (‘‘OMB’’) for

review and were approved by OMB

which assigned the following control

number 3235–0511.

The Proposing Release solicited

comments on the proposed collections

of information. No comments were

received that specifically addressed the

PRA submission. However, as discussed

in sections III. and IV. above, the

Commission received suggestions that

would improve the collections of

information. Based upon these

suggestions, the collections of

information have been adjusted as

described in sections III. above and are

in accordance with Section 3507 of the

PRA.23 These adjustments include the

adopting of two reporting formats to

increase the consistency, accuracy and

comparability of the information

collected. In addition, the adjustments

will reduce the time required to

summarize, track, analyze, and report

the information received.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the agency displays a valid OMB

control number. Broker-dealers are

required to comply with the collection

of information pursuant to the

amendments to Rule 17a–5 and the

information is necessary to provide the

Commission with a better

understanding of the security industry’s

readiness for the Year 2000. The

information collected pursuant to the

amendments to Rule 17a–5 will be

public.

Based upon the adjustments to the

amendments, the Commission is

adjusting its burden estimate. The

Commission estimated in the Proposing

Release that, on average, a broker-dealer

would spend 70 hours preparing the

Year 2000 report and obtaining the

independent public accountant’s

Attestation. The Commission estimates

that under the final amendments, a

broker-dealer will, on average, spend

two hours preparing Part I of Form BD–

Y2K and 35 hours preparing Part II of

Form BD–Y2K. The total annualized

burden to the securities industry is

estimated to be 89,000 hours. This is

based on 6,000 respondents spending

two hours preparing Part I and 2,200

respondents spending 35 hours

preparing Part II of Form BD–Y2K.

VII. Statutory Analysis

Pursuant to the Securities Exchange

Act of 1934 and particularly Sections

17(a) and 23(a) thereof, 15 U.S.C.

78o(c)(3) and 78w, the Commission is

adopting amendments to § 240.17a–5 of

Title 17 of the Code of Federal

Regulations in the manner set forth

below.

List of Subjects in 17 CFR Parts 240 and

249

Broker-dealers, Reporting and

recordkeeping requirements, Securities.

Text of Final Rule

In accordance with the foregoing,

Title 17, chapter II, part 240 of the Code

of Federal Regulations is amended as

follows:

PART 240—GENERAL RULES AND

REGULATIONS, SECURITIES

EXCHANGE ACT OF 1934.

1. The authority citation for part 240

continues to read in part as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,

77s, 77z-2, 77eee, 77ggg, 77nnn, 77sss, 77ttt,

78c, 78d, 78f, 78i, 78j, 78j-1, 78k, 78k-1, 78l,

78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w,

78x, 78ll(d), 78mm, 79q, 79t, 80a-20, 80a-23,

80a-29, 80a-37, 80b-3, 80b-4 and 80b-11,

unless otherwise noted.

* * * * *

2. By amending § 240.17a-5 by adding

paragraph (e)(5) to read as follows:

§ 240.17a-5 Reports to be made by certain

brokers and dealers.

* * * * *

(e) Nature and form of reports. * * *

(5)(i) For purposes of this section, the

term Year 2000 Problem shall include

problems arising from:

(A) Computer software incorrectly

reading the date ‘‘01/01/00’’ as being the

year 1900 or another incorrect year;

(B) Computer software incorrectly

identifying a date in the Year 1999 or

any year thereafter;

(C) Computer software failing to

detect that the Year 2000 is a leap year;

or

(D) Any other computer software error

that is directly or indirectly caused by

the problems set forth in paragraph

(e)(5)(i)(A), (B), or (C) of this section.

(ii) (A) No later than August 31, 1998,

every broker or dealer required to

maintain minimum net capital pursuant

to § 240.15c3–1(a)(2) of $5,000 or greater

as of July 15, 1998, shall file Part I of

Form BD–Y2K (§ 249.618 of this

chapter) prepared as of July 15, 1998,

and no later than April 30, 1999, every

broker or dealer required to maintain

minimum net capital pursuant to

§ 240.15c3–1(a)(2) of $5,000 or greater as

of March 15, 1999, shall file Part I of

Form BD–Y2K prepared as of March 15,

1999.

(B) Every broker or dealer that

registers pursuant to section 15 of the

Act between July 16, 1998 and

December 31, 1998 or between March

16, 1999 and October 1, 1999, and that

is required to maintain net capital

pursuant to § 240.15c3–1(a)(2) of $5,000

or greater, shall file Part I of Form BD–

Y2K (§ 249.18 of this chapter) no later

than 30 days after its registration

becomes effective. Part I of Form BD–

Y2K shall be prepared as of the date its

registration became effective.

(iii)(A) No later than August 31, 1998,

every broker or dealer with a minimum

net capital requirement pursuant to

§ 240.15c3–1(a)(2) of $100,000 or greater

as of July 15, 1998 shall file Part II of

Form BD–Y2K (§ 249.618 of this

chapter). Part II of Form BD–Y2K shall

address each topic in paragraph

(e)(5)(iv) of this section as of July 15,

1998.

(B) No later than April 30, 1999, every

broker or dealer with a minimum net

capital requirement pursuant to

§ 240.15c3–1(a)(2) of $100,000 or greater

as of March 15, 1999 shall file Part II of

Form BD–Y2K (§ 249.618 of this

chapter). In addition, each broker or

dealer subject to paragraph (e)(5)(iii)(A)

of this section shall file Part II of Form

BD–Y2K pursuant to this paragraph

(e)(5)(iii)(B) regardless of its minimum

net capital requirement. Part II of Form

BD–Y2K shall address each topic in

paragraph (e)(5)(iv) of this section as of

March 15, 1999.

(C) Every broker or dealer that

registers pursuant to section 15 of the

Act between July 15, 1998 and

December 31, 1998 or between March
37674 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations

16, 1999 and October 1, 1999, and that

is required to maintain net capital

pursuant to § 240.15c3–1(a)(2) of

$100,000 or greater, shall file Part II of

Form BD–Y2K (§ 249.18 of this chapter)

no later than 30 days after registration

becomes effective. Part II of Form BD–

Y2K shall address each topic in

paragraph (e)(5)(iv) of this section as of

the effective date of its registration.

(iv) Part II of Form BD–Y2K (§ 249.618

of this chapter) prepared pursuant to

paragraph (e)(5)(iii) of this section shall

identify a specific person or persons

that are available to discuss the contents

of the report and shall include a

discussion of the following:

(A) Whether the board of directors (or

similar body) of the broker or dealer has

approved and funded plans for

preparing and testing its computer

systems for Year 2000 Problems;

(B) Whether the plans of the broker or

dealer exist in writing and address all

mission critical computer systems of the

broker or dealer wherever located

throughout the world;

(C) Whether the broker or dealer has

assigned existing employees, hired new

employees, or engaged third parties to

provide assistance in addressing Year

2000 Problems, and if so, a description

of the work that these groups of

individuals have performed as of the

date of each report;

(D) The current progress of the broker

or dealer on each stage of preparation

for potential problems caused by Year

2000 Problems. These stages are:

(1) Awareness of potential Year 2000

Problems;

(2) Assessment of what steps the

broker or dealer must take to address

Year 2000 Problems;

(3) Implementation of the steps

needed to address Year 2000 Problems;

(4) Internal testing of software

designed to address Year 2000

Problems, including the number and a

description of the material exceptions

resulting from such testing that are

unresolved as of the reporting date;

(5) Point-to-point or industry-wide

testing of software designed to address

Year 2000 Problems (including testing

with other brokers or dealers, other

financial institutions, and customers),

including the number and a description

of the material exceptions resulting from

such testing that are unresolved as of

the reporting date; and

(6) Implementation of tested software

that will address Year 2000 Problems;

(E) Whether the broker or dealer has

written contingency plans in the event,

that after December 31, 1999, it has

problems caused by Year 2000

Problems;

(F) What levels of management of the

broker or dealer are responsible for

addressing potential problems caused

by Year 2000 Problems, including a

description of the responsibilities for

each level of management regarding the

Year 2000 Problems;

(G) Any additional material

information concerning its management

of Year 2000 Problems that will help the

Commission and the designated

examining authorities assess the

readiness of the broker or dealer for the

Year 2000.

(v) The broker or dealer shall file an

original and two copies of Form BD–

Y2K (§ 249.618 of this chapter) prepared

pursuant to paragraph (e)(5) of this

section with the Commission’s principal

office in Washington, D.C. and one copy

of Form BD–Y2K with the designated

examining authority of the broker or

dealer. The reports required by

paragraph (e)(5) of this section shall be

public.

* * * * *

PART 249—FORMS, SECURITIES

EXCHANGE ACT OF 1934

3. The authority citation for part 249

continues to read in part as follows:

Authority: 15 U.S.C. 78a, et seq., unless

otherwise noted;

* * * * *

4. By adding § 249.618 and Form BD–

Y2K to read as follows.

§ 249.618 Form BD–Y2K, information

required of broker-dealers pursuant to

section 17 of the Securities Exchange Act

of 1934 and § 240.17a–5 of this chapter.

This form shall be used by every

broker-dealer required to file reports

under § 240.17a–5(e) of this chapter.

Note: Form BD–Y2K does not appear in the

Code of Federal Regulations. Form BD–Y2K

is attached as Appendix A to this document.

By the Commission.

Dated: July 2, 1998.

Margaret H. McFarland,

Deputy Secretary.

BILLING CODE 8010–01–P
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37675
37676 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37677
37678 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37679
37680 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37681
37682 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37683
37684 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37685
37686 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations 37687
37688 Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 /Rules and Regulations

1 International Organization of Securities

Commissions, Statement of the IOSCO Technical

Committee on Year 2000 (1997), available at http:/

/www.iosco.org.

2Release No. 34–39726, (March 5, 1998), 63 FR

12062 (March 12, 1998).

3SRO is defined in Section 3(a)(26) of the

Exchange Act, 15 U.S.C. 78c(a)(26).

4All comment letters and a summary of the

comments are available in File No. S7–8–98 at the

Commission’s Public Reference Room, 450 Fifth

Street, NW., Washington, DC 20549. The comment

period closed on April 27, 1998. See also Release

[FR Doc. 98–18292 Filed 7–10–98; 8:45 am]

BILLING CODE 8010–01–E

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 240

[Release No. 34–40163; File No. S7–8–98]

RIN 3235–AH42

Year 2000 Readiness Reports To Be

Made by Certain Transfer Agents

AGENCY: Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange

Commission (‘‘Commission’’) is

adopting Rule 17Ad–18 under the

Securities Exchange Act of 1934

(‘‘Exchange Act’’) to require certain

transfer agents to file with the

Commission two reports regarding their

Year 2000 compliance. The reports will

increase transfer agent awareness of the

specific steps they should be taking to

prepare for the Year 2000; help

coordinate industry testing and

contingency planning; supplement the

Commission’s examination module for

Year 2000 issues and identify potential

Year 2000 compliance problems; and

provide information regarding the

securities industry’s preparedness for

the Year 2000. The reports are designed

to be available to the public, which will

enable issuers and other parties to

assess the risks of doing business with

a transfer agent that may not be Year

2000 compliant.

EFFECTIVE DATE: August 12, 1998.

FOR FURTHER INFORMATION CONTACT: Jerry

W. Carpenter, Assistant Director, 202/

942–4187; Thomas C. Etter, Jr., Special

Counsel, 202/942–0178; or Jeffrey

Mooney, Special Counsel, 202/942–

4174, Division of Market Regulation,

Securities and Exchange Commission,

450 Fifth Street, NW., Mail Stop 10–1,

Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

At midnight on December 31, 1999,

unless the proper modifications have

been made, the program logic in many

of the vast majority of the world’s

computer systems will start to produce

erroneous results because, among other

things, the systems will incorrectly read

the date ‘‘01/01/00’’ as being January 1

of the year 1900 or another incorrect

date. In addition, systems may fail to

detect that the Year 2000 is a leap year.

Problems also can arise earlier than

January 1, 2000, as dates in the next

millennium are entered into non-Year

2000 compliant programs. Year 2000

Problems could have negative

repercussions throughout the world’s

financial systems because of the

extensive interrelationship and

information sharing between U.S. and

foreign financial firms and markets.1

The Commission views the Year 2000

problem as an extremely serious issue.

A failure to assess properly the extent of

the problem, remediate systems that are

not Year 2000 compliant, and then test

those systems could endanger the

nation’s capital markets and place at

risk the assets of millions of investors.

In light of this, both transfer agents and

the Commission are working hard to

address the industry’s Year 2000

Problems.

As part of its ongoing efforts relating

to the Year 2000 on March 5, 1998, the

Commission requested comment on

proposed Rule 17Ad–18 that would

require transfer agents to file at least one

report with the Commission regarding

its Year 2000 compliance.2 The

proposed rule noted that transfer agents

present special considerations for the

Commission because unlike other

entities regulated under the Exchange

Act transfer agents have no selfregulatory organization (‘‘SRO’’) to

assist them and the Commission in

addressing Year 2000 issues.3 Therefore,

the Commission’s only information from

non-bank transfer agents is directly from

the transfer agent themselves.

The Commission received 26

comment letters in response to the

proposed rule.4 The majority of the